Banyan

Now for the soft part

The heyday of “factory Asia” may be ending sooner than anyone thought

PARK JAE-SANG has shown the way forward. The South Korean rapper, known as PSY, this week topped the pop charts in Britain and lay second in America. His gloriously inane video, “Gangnam Style” (with some 350m online viewings so far), has proved that Asia’s economic powerhouses can lead the world in exporting intangible goodies as well as things you can drop on your foot. Facing an alarming economic slowdown, much of Asia needs to learn the lesson: service industries are the future.

That is a crude summary of the latest “Outlook” for the region published this week by the Asian Development Bank (ADB). For almost the entire region, it is far gloomier than the ADB’s previous forecast in April—if still startlingly perky by Western benchmarks. In Asia as a whole, excluding Japan, economic growth this year is expected to slow to 6.1%, from 7.2% in 2011.

Much of this can be blamed on the feeble state of the rich-world economy. Since April, fears that the euro zone is on the brink of a cataclysmic meltdown have eased somewhat. Yet they are not about to go away altogether, and optimism over the prospects for the biggest market for much of Asia’s exports is still remote. Add in an anaemic recovery, at best, in America, and the worry that its economy might tumble off a fiscal cliff in December, and the outlook for external demand is bleak. In China exports to Europe fell by about 5% in the first eight months of this year, compared with a year earlier.

Indeed, it is China that accounts for much of the regional slowdown, with the ADB’s forecast for GDP growth in 2012 cut to 7.7%, from 8.5% just in April. Year-on-year growth in the third quarter is expected to have been not much more than 7%, the seventh successive quarterly slowdown. Investment in both Chinese infrastructure and manufacturing has grown less frenetically. Economic uncertainty has acted as a drag on consumption. Yet, by the ADB’s reckoning, “external factors” account for about two-thirds of China’s slowdown.

“Internal factors are dominant”, however, in India, which has not followed the East Asian pattern of labour-intensive manufacturing and export-led growth. There the ADB has made an even sharper cut in its forecast for 2012 growth, from 7% to 5.6%. A late monsoon, continued inflationary pressures and a government that has only just started trying to escape from policy paralysis have all dented investor and consumer confidence.

Slower growth in China and India has a knock-on effect in the rest of Asia, for which China in particular is an ever more important market. Yet South-East Asia is proving rather resilient, even if the new kid on the regional block, reforming Myanmar, has too small an economy yet to have much of an impact. In Indonesia growth is driven largely by domestic demand and is still on course to reach around 6% this year. The Philippines, a new favourite among some foreign investors, may fall not far short of that. Thailand, meanwhile, has recovered rapidly from calamitous flooding in 2011.

However, developing Asia faces a challenge more fundamental than riding out another cyclical downturn in the West. The ADB has warned before of the dangers of growth fuelled by natural bounty and cheap labour. As wages rise, manufacturers find themselves unable to compete either with lower-cost producers elsewhere or, in higher-value-added products, with more advanced economies. They get stuck in a “middle-income trap”.

Now the ADB is arguing that, with demand from the advanced economies for its manufactures unlikely to pick up strongly soon, Asia needs to shift to a model based more on rising domestic demand and relying more on its service industries. As farmers’ children across Asia have left the land to work in factories, farming’s share of output has dropped, so industry’s share is now far higher than in the OECD countries. But before developing Asia’s industrialisation has run its course, the region needs to replicate the success in services, which now account for just 48.5% of its GDP, compared with 75% in advanced economies.

Asia has some extraordinary success stories in high-end services: not just the “Korean wave” washing through the world’s pop cultures, or the Bollywood movies watched from Kandahar to Kansas, but some of the world’s best airports, airlines and hotels. Then there is India’s world-beating information-technology services and outsourcing industry. Last year this produced $76.4 billion in revenues and employed 2.5m people.

That is a drop in the ocean, however, in India’s half-a-billion-strong labour force, even counting the four additional jobs elsewhere that each IT job is claimed to create. Most of those working in what count as service jobs across Asia lead less modern and productive lives: shopkeepers, rickshaw-pullers, foot-masseuses, security guards, barbers, road-sweepers, dhobi-wallahs, lift attendants, rubbish-pickers and so on. What is needed, the ADB argues, is a boost for “high-value modern services”, such as IT and finance. This would create jobs (especially for women), meet the growing need of an urbanising population for more sophisticated services, and open up new export markets.

Blocked service roads

The obstacles to this are huge, including the shortcomings of education systems, telecommunications and other infrastructure and, in the ADB’s words, “above all, burdensome regulations which protect incumbent firms”. Powerful vested interests, like some of China’s state enterprises (see article), stand in the way.

A strong service sector does not ensure an escape from the middle-income trap, or lessen the importance of industry. The two places where services have leapfrogged manufacturing, India and the Philippines, are a long way from rich-country status. But without more developed services, Asia will struggle to generate the decent jobs its people will need as it gets used to what the ADB calls a “new era of moderate growth”.